Evaluated receipts settlement (ERS) and tax compliance.

A Report of the Steering Committee Task Force on EDI Audit and Legal Issues for Tax Administration

Foreword

The Task Force on EDI Audit and Legal Issues for Tax Administration (Task Force) was formed to coordinate efforts between the business community and tax administrators in analyzing and addressing the issues posed for tax administration by electronic data interchange and related business processes. The Task Force is composed of representatives of the Committee On State Taxation (COST), Institute for Professionals in Taxation (IPT), Tax Executives Institute (TEI)(*), Multistate Tax Commission (MTC), and Federation of Tax Administrators (FTA), and commissioners from several state tax administration agencies. This report is the fourth in a series of reports to be published by the Task Force on issues relating to electronic commerce, emerging business processes and tax administration.

Through the Task Force process, the Electronic Business Processes work group was formed to examine the tax administration and compliance issues associated with certain emerging business processes, including the use of evaluated receipts settlement (ERS). A large group of taxpayer representatives and tax administrators gave freely of their time in an effort to understand the issues involved and to identify solutions which would meet the needs of both taxpayers and tax administration agencies.

This report is the product of that effort. It describes the ERS process and the benefits derived by its use. It identifies audit and recordkeeping issues, the type of accounting information created and retained, and outlines potential solutions that would be helpful in addressing the issues raised by the use of ERS. As with the report itself, the recommendations are premised on a need for all parties to work together to resolve the issues.

The Steering Committee wishes to acknowledge the contributions of all individuals who devoted their time and effort in developing and refining this report. A complete list of participants can be found in Appendix E.

Stanley R. Arnold, Steering Committee Chair Commissioner, New Hampshire Dept. of Revenue Administration

September 1998

Introduction

On October 7, 1994, the Federation of Tax Administrators (FTA) hosted a meeting to begin the process of forming a task force of state and private sector tax administrators to address Electronic Data Interchange (EDI).

On May 2, 1996, the steering committee of the task force met to discuss several additional issues related to electronic business processes utilized by taxpayers and tax authorities. Based on these discussions, the steering committee formed two new work groups to review issues and develop recommended procedures for taxpayers and tax authorities to follow. One of these groups, the Electronic Business Processes work group, is focusing on business issues such as corporate procurement cards, evaluated receipts settlements, exemption/resale certificates, and direct pay permits.

The objective of this work group is to develop white papers that outline the issues and discuss possible options for taxpayers and taxing authorities to follow to ensure the necessary documentation is available for tax compliance and tax audits.

Evaluated Receipts Settlement (ERS), also referred to as Auto Pay, is a relatively new "business process" which is growing in popularity in the business community. In developing this white paper, the work group identified the following areas: (1) how this process works, (2) why taxpayers are increasingly using ERS, (3) the issues created by the use of ERS, and (4) potential alternatives to ERS use.

The ERS white paper represents the considerable work product of a large number of tax administrators and taxpayer representatives. Since ERS is a relatively new business process, this work group urges state tax administrators to educate their audit groups in this area. Traditionally, the obligation to calculate and remit sales tax is imposed on the supplier. Since the supplier no longer has complete control over the tax calculation function when using ERS, this becomes more complicated. However, it is important that the supplier realize that he still has primary tax responsibility and is not relieved of his obligations. The recently issued Auditing Electronic Data white paper by this task force provides general guidelines that are applicable to auditing ERS transactions. However, there are notable variations from electronic data interchange (EDI) that could raise audit issues. Thus, education of the audit workforce is critical to an efficient and effective tax administration process.

Evaluated Receipts Settlement (ERS)

What Is It?

ERS is a business process between trading partners that conduct commerce without invoices. In an ERS transaction, the supplier ships goods based upon an Advance Shipping Notice (ASN), and the purchaser, upon receipt, confirms the existence of a corresponding purchase order or contract, verifies the identity and quantity of the goods, and then pays the supplier.

How Does It Work?

A supplier and its purchaser enter into an agreement to use evaluated receipts settlement. The supplier keeps the purchaser current with price/sales catalogue data from which the purchaser extracts accurate product and pricing information during the purchasing cycle. The supplier delivers the ASN to the purchaser, permitting loading/receiving docks to be properly scheduled and accurate material receipts to be generated. The purchaser authorizes supplier payment upon confirmation of arrival of goods, making the invoice redundant.

Although there are numerous variations of how ERS specifically works, there are several common elements:

1. Pricing Information -- A list or catalogue of products and prices is sent by the supplier to its purchaser. The information has an agreed upon "shelf life" (30 days, 60 days, etc.). This pricing information may be sent to the purchaser electronically, faxed, or in a paper form. In some cases, it becomes a part of the written contract.

2. Products/Goods Ordered -- A purchaser using the pricing information sent by the supplier places an order.(1) Usually a purchase order specifying quantity, product type, price, freight, tax, etc. is generated. This purchase order may be sent electronically (EDI), via fax, or paper. This purchase order has a unique number for the specific order. Some purchasers do not issue a purchase order but rather place their goods order pursuant to the specific terms and conditions of a contract. The specific contract number is referenced. The order may be placed via EDI, fax, paper, or orally.

3. Advance Shipping Notice (ASN) -- A supplier acknowledges the order by sending an ASN to the purchaser. The ASN is usually sent electronically to the purchaser. In an EDI environment, ANSI X12 Transaction/Data Set 856 (Ship Notice/Manifest) is used. Note that transaction set 856 does not contain pricing or tax information.

4. Goods/Products Shipped -- The supplier ships the goods with an itemized bill of lading or packing slip which references the purchase order or contract number.

5. Validation/Matching Process -- The purchaser matches the goods receipt (bill of lading, packing slip) to the ASN, purchase order, or contract to validate accuracy.

6. Payment Process -- Instead of...